Investing in such firms comes with higher risks because it is hard for the average investor to even find out whether information about the companies is genuine.
Worse, investors are often so blind-sided by promises of huge returns that they forget to check whether the deal is worth paying for. Here are two cautionary tales about investors who went to the High Court over disputes related to their stakes in private businesses.A housewife invested $300,000 to buy a 5 per cent stake in a fitness company that was supposedly worth $16 million even though she was an unsophisticated investor who seldom bought shares on the stock market.
The daughter then saw that the company had a paid-up capital of only $900,000 – at this amount, her mother’s 5 per cent stake would be worth about $45,000. She also saw financial statements showing that the company made only $97,000 in profit in 2018 and a loss of about $22,000 in 2017. But she was caught out barely a year later when the partners implemented a “stock split” of one-for-54 for their original holdings, a process that increased their total shares to 270,000. The pub would have 300,000 shares after the split, meaning the young investor’s stake was reduced to just 10 per cent.The woman, who did not get involved in the pub’s operations or ask to be appointed a director, naturally cried foul over the dilution of her stake that turned her into a minority shareholder.
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